Felix Salmon

Information wants to be expensive

By Felix Salmon
July 12, 2013

What a difference a decade makes. In 2003, when the SEC announced its big settlement on Wall Street research, everybody greeted with joy the way in which it provided more than $400 million to fund independent research over five years. While sell-side research has its place, there are good reasons why investors want research shops to be independent, and the SEC settlement was designed to give such shops something of a running start, with guaranteed income.

The logic here is simple: information is good for markets. It improves price discovery, and in doing so helps to optimize capital allocation. But detailed information does not come cheap, and there are lots of reasons why paying for information directly is a much cleaner and much more sensible way of doing things than hiding the payments within the cross-subsidy arrangements of investment banks. As we saw during the Blodget era, investment banks have their own incentives, which aren’t always aligned with those of investors.

Sadly, the independent research industry never really took off, the fuel of the SEC settlement notwithstanding — and when the end of the five-year settlement period coincided with the onset of the financial crisis, that was pretty much the end of that. But still, there are independent institutions out there which put substantial resources into sourcing and publishing important information about the various sectors of the economy — information which is invaluable for the market. The more such information we have, the more efficient the market becomes.

In a market economy, however, all that research and information has to be paid for somehow. Luckily, there’s a time-tested means of doing so: you charge money for it. Investors value information, especially if (a) it has the potential to move the markets, and (b) they can get a “peek” at the information before it is broadly released to the public. The result is a mini industry of information providers, who put a lot of effort into surveys and analysis and other means of data collection, and who pay for it all by selling that information to investors. Rather than trying to legislate independent research through SEC settlements, this is the much more efficient free-market solution, and it’s one in which everybody wins: the information providers get paid, the investors get access to valuable information, and the market as a whole more efficiently reflects all the new knowledge about the state of the economy.

But now that we’ve found a way that independent economic research can actually pay for itself, it turns out we don’t much like it. At the WSJ, Michael Rothfeld and Brody Mullins have been bashing this drum for a while now; on Tuesday they wrote an article explaining, in the words of the headline, that “Peeks Are Still Available for Some Key Economic Data”, and then today they followed that article up with another one, almost identical, under the headline “A Peek at Trucking Data, and Then the Stock Surged”. Breaking: new data can move markets! Here’s my favorite part of the article:

The Association of Home Appliance Manufacturers distributes monthly shipment data to nonmembers who pay $600 a year. The data can affect trading in such stocks as General Electric Co., Whirlpool Corp., and AB Electrolux. The group also gives its monthly appliance-shipments report to 20 member companies that participate in the survey a day in advance.

Spokeswoman Jill Notini said the association relies on the honor system: “We hope they would use the data appropriately.”

I’m not sure what the “honorable” and “appropriate” use of the data is, in this context, but the implication is clear: if you trade on this information in the market, before it is broadly available, then that would be dishonorable and inappropriate.

Why would such activity be dishonorable or inappropriate? The WSJ doesn’t say. And why would anybody care about getting such information 24 hours in advance if they couldn’t trade on it? There might be insider-trading reasons why a company can’t trade on non-public information from a survey to which it itself contributed, and in general I’m not sure that corporate treasury departments should be in the stock-market speculation business. But putting that to one side, trading on information is a public good, and it should be encouraged as much as possible.

Trading is, after all, the primary mechanism by which market information is reflected in market prices; in many ways, it’s the whole point of having markets in the first place. And in general, no one’s going to trade if they don’t think they have some kind of edge.

The perceived problem with “peeks”, as I understand it, is one of fairness and level playing fields: the ordinary individual investor is at a disadvantage, relative to the large institutional investors with advance access to information. But that seems very old-fashioned: the ordinary individual investors is always at an information disadvantage, which is why it’s so silly for ordinary individual investors to trade much, beyond the occasional rebalancing. Even when information is released simultaneously to all market participants at once — through an SEC filing, say, or in a press release — you can be sure that the HFT algobots will have acted on it long before any individual investor has even had time to read the headline.

Or to put it another way: back when it was founded, in the 1930s, it made sense for the SEC to try to enforce a “fair” market where all men could trade on a level playing field. But those days are over now, and they’re never coming back. Everybody knows that hedge funds and institutional investors have access to massive amounts of information, on top of high-level access to executives; everybody knows that high-frequency traders can move much more quickly than any individual. If you want to go up against these people in the trading arena, all power to you — but don’t expect the SEC to be able to ensure that it’s a fair fight.

Instead, individual investors should play to their strengths, which include the ability to take a long view and not feel any need to mark to market, or to worry about quarterly performance returns. They can make long-term investments without worrying about short-term performance, and — thanks in large part to the rise of high-frequency trading — they can get truly spectacular execution at NBBO at any time they want it. Sometimes, data will cause stocks to move — all individual investors know that, and if they have their priorities straight, they won’t particularly care when that move takes place.

But from a public-policy perspective, the market in data is a good thing, which should be encouraged: the more data there is, and the higher the quality of that data, the better that the economy is served by the market. The institutions providing this data are performing an important public service, and being paid for it from private-sector funds. Let’s celebrate that, rather than demonizing them.

9 comments so far | RSS Comments RSS

bravo on your last 4 paragraphs, Felix… that’s my mantra exactly…

Posted by KidDynamite | Report as abusive

Great article, Felix. The only issue I would take with it is that even in 1930 information was asymmetrical. I suspect that even then the drafters of the law didn’t really believe a level playing field was possible.

Posted by TomLindmark | Report as abusive

Great article, Felix. The only issue I would take with it is that even in 1930 information was asymmetrical. I suspect that even then the drafters of the law didn’t really believe a level playing field was possible.

Posted by TomLindmark | Report as abusive

I agree with Felix’s broad point, but I was troubled by the example of the appliance manufacturers’ survey, because it sounds like the shipment information comes from public company manufacturers themselves. It is aggregated, but I still view it as different than information derived from surveying the public or even sales channel surveys of customers and distributors.

Posted by realist50 | Report as abusive

Me thinks you are falling for the magician’s ruse, much like one previous President Bush, who needed to ‘destroy the market to save it.’ It’s a matter of viewpoints, much like the centrifugal force in Physics…your frame of reference, when looking at these market forces, helps make things impossible to understand, or very easy.

Information is information; man wants information to be expensive, since profits are what man seeks, and, in certain misapplications of market algorithms, market segmentation of sorts is the means by which he seeks to make it happen. Or rather, a man wants information to be inexpensive when he is buying, and expensive when he is selling; double so if he is selling to his neighbors.

Now, sometimes information is expensive by consequence: a new chemical formula that creates a drug that cures a bothersome disease -> this is seen as a good thing, and richly rewarded by the market. But sometimes information is expensive by artifice: illegal barriers, political corruption, and broken agreements acting in unison to take public information, much like a public beach, and close it off. That it was not owned by the new owners previously matters little after they have erected barriers around it, and paid off others to spread their deception.

Currently the market, the global market, is suffering a grand tummy-ache, IMHO: it’s not a matter of the new generation not wanting to work, but that the deals that the older generation is offering the new one are so bad, that even the spirit of the market itself is balking at them. The market, which was built upon the idea of voluntary exchange of labor to better mankind, and the free flowing of capital, has been transformed, through relentless corruption, into something approaching a market for slavery -> a lockdown on capital and labor is seen, feudal lords appearing out of the abyss, and mandates that cannot be upheld because it runs contrary to the underpinnings of reality itself. It is as if there was an agreement that the market be instituted properly…then everyone began running overrides on it, because they grew skittish that the high places they started out at were not being maintained; as such, once you issue an override, as has been done, you are no longer operating in a market economy, but a political one. I liken it to the Model-View-Controller design in the programming world, where once you break the design (by introducing some non-MVC controls, for instance), you are no longer doing MVC.

Posted by rossryan | Report as abusive

I think there is something wrong here.
The problem is that the market is now divided into people who have costly information and people who don’t. People who don’t won’t trade on days when this information is released. So people with this information will delay using it, since their profit comes from people without this information. (i.e. This becomes a bluff and double bluff game of poker). Is this how we really want markets to work? There is a fundamental problem – the information is more valuable, the fewer people who have it. And once some people have it, before long everybody will have it. So the information will naturally tend to become more expensive and more exclusive – which is the opposite of the desired effect of informing the market better.

Posted by jimvb | Report as abusive

Felix, They aren’t actually buying the information — they are buying a trading advantage. If you want to go out and tell people that the public markets are stacked against them so don’t bother, then be my guest. I concluded this a decade ago. But the last time I checked there is still an awful lot of money being made when individuals trade. Which is to say, that if you limit the market to “power” buyers and sellers these agents will all buy the so-called trading advantage that is marketed by Reuters or others, at which point it will then cease being an advantage. What they hope for is the gauzy illusion of a level playing field while the reality is an unlevel playing field. It’s a form of arbitrage and no matter how you slice and dice it, the rest of us are reasonable in concluding that there is no reason whatsoever to participate in a market that is so heavily stacked against us. If you’re down with that, then just say so.

Posted by rb6 | Report as abusive

We need to unpack the two second prerelease to see what’s disgraceful about it. I don’t mean that an information advantage is disgraceful, or that the business of developing and selling information advantages is disgraceful. I mean very specifically that this example is disgraceful.

Start by stipulating that a two second information advantage can only be used by a certain type of firm. That should be easy to see. What kind of firm is it? It is an automated trading firm. And over the last 10 or 15 years these firms – especially the largest among them – have worked with regulators and exchanges to implement and mainstream a variety of regulatory changes and facilities favorable to them that were once unknown, even unimaginable. (I’m writing specifically about the US equities market.)

First is the co-location of their trading computers with exchange computers to minimize communications time; next, the distribution of enriched, private data feeds which describe in great detail what exchange order books look like and detail their dynamic behavior; next, regulatory privileges that allow these firms to print money – quite literally – over short timeframes, giving them unlimited leverage in those timeframes; next, regulatory privileges that allow these firms to short stocks without any of the handcuffs that bind ordinary investors or ordinary broker dealers; next, on some exchanges, order types and trade priorities that favor them; next, the repeal of regulatory obligations these firms once had as a quid pro quo for their privileges.

So these firms start with extraordinary power and reach over any other investors, and what gives them that power is more than just capital investment, it’s regulatory advantage. No ordinary investor, mutual fund, or hedge fund has unlimited leverage in any timeframe at all. Mutual funds can’t short stocks at all; ordinary investors or hedge funds can short stocks, but only if they abide by regulations that are intended to limit the practice (margin requirements and locates for the practitioners out there). As for mutual funds, there’s absolutely nothing they can do, by law, for them to acquire the registrations (licenses) they need to enjoy the privileges these firms have.

All these regulatory advantages and facilities were intended – or so the propaganda said – to allow these firms to make markets, provide liquidity, dampen volatility, and improve competition in the markets.
But here we find these firms using these regulatory advantages and facilities to act as superpredators in the markets. All they need is a two second advantage to position themselves. They put on those positions by taking liquidity and causing volatility. Then they flip those positions as quickly as they can for a profit.

There’s no investment, liquidity provision, volatility dampening, or level playing field here. There is only a very small class of highly privileged and aggressive traders that somehow convinced a news organization to provide – or were convinced by a news organization to buy – an information advantage that they, and only they, were uniquely able to profit from at the direct expense of everyone else.

And that’s why it’s a disgrace.

Posted by SummerDay | Report as abusive

The various stock exchanges used to boast about offering a level playing field where even the little guy could trade with the big guys without getting unfairly stomped. I remember the talk when my class went to the gallery overlooking the NYSE trading floor, back when you could go there without a pat down and metal search. I remember the old NASDAQ with its old motto: My word is my bond. back when it was a bunch of brokers with note pads and telephones. The markets don’t need the little investors anymore and the little investors don’t need them. Actually, the big investor don’t need them either. The brokers at Vanguard, Fidelity and the other institutional investors all have telephones and note pads these days.

Posted by Kaleberg | Report as abusive

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